The yuan rose strongly against the dollar in the offshore forwards market on Friday because of speculation that China's economy would soon start recovering, reducing the chances of yuan depreciation this year. One-year dollar/yuan non-deliverable forwards (NDFs) dropped as low as 6.8850 bid, their lowest level since mid-November, from 6.9300 at Thursday's close.
That confirmed a break below the range of roughly 6.95-7.10, which NDFs had maintained since mid-December. Their low implied yuan depreciation of just 0.70 percent against the dollar over the next 12 months from the day's spot mid-point, against 1.36 percent depreciation implied at the close on Thursday. One-year NDFs have not implied yuan appreciation since the end of last September, but some traders said they could resume doing so in coming weeks if Chinese economic data remained positive.
"Sentiment has changed in the NDF market, encouraged by the latest PMI figures which show signs of economic recovery," said a trader with a major European bank in Shanghai. "It's possible that one-year NDFs could imply yuan appreciation soon. But such optimism could be short-lived if other key economic indicators for January turn out to be less encouraging."
A better-than-expected China purchasing managers' index for January, and news of very strong bank lending growth during the month, have fuelled hopes that economic growth could begin rebounding in the next few months. This has pushed the stock market, and medium- and long-term Chinese bond yields and interest rate swaps, up sharply.
Dollar/yuan volatilities, which were supported by hedging against the possibility that slumping exports would prompt China to engineer yuan depreciation later this year, have dropped back this week. One-year vols sank as far as 8.75 percent bid on Friday, their lowest level since late September, from 9.75 percent bid at Thursday's close and 11.35 percent at the end of last month.
However, spot yuan was almost unchanged against the dollar on Friday, finishing at 6.8344 against Thursday's close of 6.8367; traders expect the Chinese central bank to continue for at least some weeks or months to use its mid-point system to maintain the range of roughly 6.81-6.88 that has prevailed since July. Central bank governor Zhou Xiaochuan has indicated that while the global financial crisis continues, China will want to keep spot yuan very stable against the dollar.
On Wednesday, Zhou said the crisis was an important factor in the central bank's thinking about the exchange rate, adding that China's foreign exchange policy would be different than in normal economic times. The central bank set the yuan's mid-point against the dollar on Friday at 6.8371, almost unchanged from 6.8360 on Thursday.